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METHODS OF ASCERTAINING 


THE 

COST OF CARRIAGE 



JOHN B. DAISH 

'i 


WASHINGTON, D. C. 








v 



&y Transfer 
D. C, Public Library 
AUG 17 1934 


BUMjlJ himm 




METHODS OF ASCERTAINING COST OF 
CARRIAGE 

By JOHN B. DAISH 

[Reprint from Green Bag , March, 1907] 

The purpose of this paper is to consider the several 
methods which have been used by tribunals to ascertain the 
cost of transporting - freight—that cost being the cost to the 
carrier. 

It is assumed, first of all, that charges for transportation 
should bear some relation to the cost of transportation. 
What this relation shall be, and whether or not cost shall 
exceed charges or vice versa, we shall not now attempt to con¬ 
cern ourselves with; we simply assume the fact that some 
relation should exist between these figures when ascertained. 

It may be argued that, from a legal point of view, the 
cost of transporting goods having been once obtained, we 
are scarcely wiser than before. The Supreme Court of the 
United States has held that as a matter of law it is im¬ 
proper, in considering the reasonableness of a rate, to make 
a comparison of the intra-state rates of two states, and it 
is likewise improper, as a matter of law, to compare the 
intra-states rates of one state with the rates applying on 
interstate traffic originating in, destined to, or passing 
through the state which we have under consideration. 
However this may be as a matter of law, certain it is, that 
as a matter of business, no stronger argument can be 
adduced than to show by mathematical process that the 
rates of one state are greater or less than those of another; 
or that the local state rates are very much more than the 
interstate rates for traffic which, in its transit, enters the 
state one may be considering . 1 

We shall further assume that there has been determined 
and crystalized into currency, what we mean by the term 
“fair valuation” of the carrier’s property. We are sup- 


1 Smyth v. Ames (169 U. S..466) 









4 


posed to have agreed to consider some figure which may not 
be entirely dependent upon any one, but in fact an infer¬ 
ence, if you please, from all of the following items: The 
cost of construction, the cost of reproduction, the valuation 
as a going concern, the valuation of the services of the 
entrepreneur; in short, we have placed in figures the “fair 
valuation” of the carrier’s property in accordance with the 
rules of law, the demands of justice, and the requirements 
of good business . 2 

One other assumption, and that is that the carrier has 
given us upon oath such testimony as we shall have called 


for 


It should be remembered in considering this matter that 
cases involving the cost of traffic to the carrier may take 
j either one or two forms, namely, of the schedule as a whole, 
or of a particular commodity. If we consider the schedule 
as a whole, we must perforce conclude that we have simply 
arrived at the beginning when we get our final figures, for 
we shall then be compelled to determine what relation each 
of the eight thousand articles in the classification shall bear 
to this average cost. If, on the contrary, we consider the 
cost of transporting a particular article, we shall then be 
under the necessity of determining what relation should 
subsist between the charges to be made for transporting this 
particular article and the cost of its transportation, and, if 
we are to aim at completeness, the relation between the cost 
of transporting this article and others or the relative charge 
to be made for them. 

Cases requiring the ascertainment of the cost of trans¬ 
porting freight per unit arise in one of two ways; either 
a statute or an order of a railroad commission has prescribed 

2 The “fair valuation” of the carrier’s property must be taken into 
consideration in determining the reasonableness of its rates and 
charges. The elements which must be taken into consideration to 
ascertain the “fair valuation” have been named by the Supreme 
Court, but no definite mathematical rule by which to crystalize the 
“fair valuation” into currency has as yet been expressed. The ele¬ 
ments are to be found in Smyth v. Ames (169 U. S. 466, 546). Upon 
the general subject concerning the necessity for considering the “fair 
valuation” of property as an element of reasonable charges, — 
Ivindsley, “Rate, Regulation of,Gfis and Electric Lighting.” 







5 


a schedule of rates or a preliminary investigation to ascer¬ 
tain the cost precedes the making of such a schedule. 

One of the earliest cases in which it was attempted to 
ascertain the cost of transportation was the case of Smyth v. 
Ames. 3 In that case the legislature of Nebraska had pre¬ 
scribed a schedule of rates applicable to the state tonnage 
moved upon all the carriers operating within that common¬ 
wealth. The facts before the courts were as follows: By 
expert testimony it was said the legislature-made rates re¬ 
duced the charges upon freight traffic 29 V? per cent; it was 
in evidence from expert witnesses that the cost of moving 
the purely intra-state traffic was from 10 to 25 per cent 
more than the cost of moving the interstate traffic, the court 
assumed that 10 per cent increase was a reasonable one; 
figures were introduced showing operating expenses and 
receipts, number of passengers carried, the tons of freight, 
and the mileage over which freight was transported. 

With such evidence at hand, after separating the pas¬ 
senger traffic from the freight traffic, the court used the fol¬ 
lowing method. Dividing the cost of freight operation by 
the receipts from freight operation, a result was produced 
of 66.24. These figures (66.24) were said to show the 
percentage which the operating expenses bore to the re¬ 
ceipts upon all the traffic carried by the railroad, and hence 
represented the cost of carrying. As the evidence showing 
that the cost of doing the intra-state freight business ex¬ 
ceeded the cost of doing all business 10 per cent, this last 
figure was added to the quotient heretofore obtained, making 
a total of 76.24. The legislature-made rates would reduce* 
(according to the testimony) the receipts 29per cent 
That is to say, for each $100 of receipts, if it be assumed 
that the quantity of tonnage will not change (and the com : 
made such assumption) the carrier would receive $70 50: 
Thus, under the legislature-made rates (and it being as¬ 
sumed that there would be no increase in tonnage) the car¬ 
rier would expend in operating expenses $76.24 and receive 
in return $70.50. Of course, upon such a basis the court 
held the legislature-made rates of Nebraska unconstitutional, 
for the proposed rates would not be remunerative. 


3 169 U. S. 466. 




b 


The fallacy of the mathematics of this case can be seen 
from two points, even if we concede that there will be no 
increase or decrease in the yearly tonnage by reason of the 
change of rates or commercial conditions. 

1. The percentage which the operating expenses bear to 
the receipts does not mean anything; it simply shows the 
relation between the two items; they both might be 
relatively high or low, or one or the other may be entirely 
disproportionate to fairness or good management or justice. 

2. Again, a careful consideration of the exhibits in the 
case shows the prospective effect of the proposed reduction 
of rates upon several carriers. If this change of rates pro¬ 
duces a reduction for one carrier, it is fair to conclude that 
it must produce a reduction for another. And so, if it pro¬ 
duce a reduction for one carrier in a single year, it must 
produce a reduction for that carrier every year. Such, 
however, is not found to be the case. For example, the Fre¬ 
mont Company was shown, had this reduction of rates been 
applied in 1891, to have gained, while seven other roads 
would have lost; and, in 1892, the Fremont Company would 
have lost with five other companies, and the Union Pacific 
(which had been a loser the year before) would become a 
gainer; further, the Fremont Company in 1893 shifts to the 
other side of the line, becoming a gainer and holding the 
Union Pacific with it, while five other companies still remain 
losers. 4 

4 The statistics cover three years, 1891, 1892, and 1893. The com¬ 
panies were the Burlington, St. Paul, Fremont, Union Pacific, 
Omaha, St. Joseph, Kansas City. In 1891, had the earnings under 
the law been reduced, according to the expert testimony (29% per 
cent) the several companies would have lost from 5.74 per cent to 
59.76 per cent, except the Fremont Company, which would have 
gained 10.63 per cent. In 1892, the several companies would have 
lost from 3.73 per cent to 32.62 per cent, except the Union Pacific 
Company, which would have gained 4.06 per cent (the year before 
this company would have lost 8.44 per cent). In 1893, the several 
companies would have lost from 1.55 per cent to 33.64 per cent, except 
the Fremont Company and the Omaha Company, the forming gaining 
6.84 per cent and the latter 1.99 per cent. The table in full is to be 
found in 169 U. S. 535. 



7 


Thus, it clearly appears that there must be some error in 
the mathematical method of this case. 

The Supreme Court had occasion to consider the cost of 
transportation in the so-called South Dakota Case. 5 In that 
case a schedule of rates had been prescribed by the railroad 
commission of South Dakota. Here the Circuit Court 
assumed that for succeeding years the tonnage carried by 
the railroads would remain substantially the same, and it 
undertook to separate the passenger and freight business, 
and found from the testimony that the gross receipts from 
passenger business, had the legislature-made rates been in 
effect, would be reduced 15 per cent, and a reduction in 
freight charges would have diminished the gross receipts 
from that source by 17 per cent. It was also found that 
the cost of doing the business, as expressed in the term 
operating expenses, would be practically the same. The 
court below found the value of the particular carrier’s 6 7 
property in South Dakota to be $10,000,000, 7 but it was 
held that it was not fair to consider that sum as employed 
in doing the local business, for the same property was 
employed in doing the interstate business. The court 
below also found that the true way to determine the value 
of the property which is employed in the local business was 
to divide the total valuation of $10,000,000 according to 
the proportion that existed between the amount of gross 
receipts from the interstate and from the local business, 
both of which amounts were accurately stated. 8 Upon this 
basis of division it was found that the value of the property 
employed in local business in a particular year 9 was 
$1,900,000; dividing this amount by the gross receipts from 
local business, it was ascertained that these receipts repre¬ 
sented 16.03 per cent of the valuation. The court then 
proceeded upon the supposition that the commission’s 

5 C. M. & St. P. R. R. v. Tompkins (176 U. S. 171). 

6 C. M. & St. P. R. R. 

7 This fact was found by the court below, notwithstanding evidence 
to the effect that it was bonded for over $19,000,000. 

8 The receipts from local and interstate business were ascertained 
from the testimony of the carrier. 

9 The court considered the effect of the statute for four years. 




8 


schedule of rates had been enforced during the year it had 
been considering. Taking the supposed reduce4 earnings, 
it found that the valuation of the carrier’s road engaged in 
the local business would have been $1,600,000, and upon 
such basis that the gross receipts from local business (under 
revised schedules) would have amounted to 16.02 per cent 
of the valuation of the property. As a matter of law, it 
was held that the variation of percentage was not sufficient 
to justify a declaration that the reduced rates prescribed by 
the commission were unreasonable; in short, the court 
below was of the opinion that the earning capacity of the 
road was so slightly reduced that it could not be affirmed 
that the new rates were unreasonable. 

Commenting upon this method the Supreme Court of the 
United States suggests that there must be some fallacy in 
it for reason that while the new schedule would reduce the 
actual receipts on freight business 17 per cent, the earning 
capacity was diminished only one-tenth of one per cent. 
“Such a result,” says the court, “indicates that there is 
something wrong in the process by which the conclusion is 
reached.” To show the fallacy of this method and attempt 
to ascertain the cost of transportation, the court took round 
numbers. “Suppose the total value of the property in 
South Dakota was $10,000,000, and the total receipts from 
both interstate and local business were $1,000,000, one-half 
from each, Then, according to the method pursued by the 
trial court, the value of the property used in earning local 
receipts would be $5,000,000, and the per cent of receipts 
to value would be 10 per cent. The interstate receipts 
being unchanged, let the local receipts by a proposed sched¬ 
ule be reduced to one-fifth of what they had been, so that 
instead of receiving $500,000, the company only receives 
$100,000. The total receipts for interstate and local busi¬ 
ness being then $600,000, the valuation of $10,000,000, 
divided between the two, would give to the property 
engaged in earning interstate receipts in round numbers, 
$8,333,000, and to that engaged in earning local receipts, 
$1,667,000. But if $1,667,000 worth of property earns 
$100,000 it earns 6 per cent. In other words, although the 
actual receipts from local business are only one-fifth of 


9 


what they were, the earning capacity is three-fifths of what 
it was. And, turning to the other side of the problem, it 
appears that if the value of the property engaged in inter¬ 
state business is to be taken as $8,333,000, and it earned 
$500,000, its earning capacity was the same as that em¬ 
ployed in local business—6 per cent. So that although the 
rates for interstate business be undisturbed, the process by 
which the trial court reached its conclusion discloses the 
same reduction in the earning capacity of the property 
employed in interstate business as that employed in local 
business, in which the rates are reduced. Again, in another 
way, the error of the court’s computation is manifested. 
The testimony discloses that the operating expenses of the 
entire system during each of the four years were over 60 
per cent of the gross receipts. If the cost of doing local 
business in South Dakota was the same as that of doing the 
total business of the company, then the net earnings of that 
local business would not exceed 40 per cent of the gross 
receipts. Reduce the gross receipts 15 per cent, and the 
reduction by the defendant’s rates was 15 per cent on pass¬ 
enger and 17 per cent on freight business, it would leave 
only 25 per cent of the gross receipts, as what might be 
called net earnings, to be applied to the payment of interest 
on bonds and dividends on stock. But the testimony shows 
that the cost of doing local business is much greater than 
that of doing through business. If it should be 85 per cent 
of the gross receipts (and there was testimony tending to 
show that it was as much if not more) then a reduction 
of 15 per cent in the gross receipts would leave the prop¬ 
erty earning nothing more than expenses of operation. 
These computations show that the method which the court 
pursued was erroneous, and that without a finding as to 
the cost of doing the local business it is impossible to 
determine whether the reduced rates prescribed by defend¬ 
ants were unreasonable or not. 10 

10 The decree of the trial court dismissing a bill to restrain the enforce¬ 
ment of a schedule of maximum rates was reversed, but the court in 
its opinion recommended that the testimony should be referred to 
some competent master, general or special, to make finding of facts. 



10 


In a recent case 11 before the Kentucky Railroad Com¬ 
mission, an attempt was made to arrive at an approximation 
of the cost to a carrier for doing the freight service in that 
state during the year 1905 upon a ton mile basis. It was 
in evidence from the carrier what amount of the money was 
properly chargeable to the intra-state freight traffic. This 
was separated by the carrier into two parts, one chargeable 
to haulage or transportation and the other to services other 
than haulage or transportation, such as terminal charges. 
It was decided that the total of the amount chargeable for 
haulage is fairly apportionable between intra- and interstate 
freight upon the basis of total ton miles. The charges for 
services other than haulage or transportation was said to 
be fairly apportionable between each of the two classes of 
freight based upon the number of tons. The carrier having 
given figures as to the average length of haul of interstate 
and intra-state freight, the amount chargeable to charges 
other than for haulage was divided by the number of tons, 
(inter-plus intra-state) and this was found to give an aver¬ 
age charge per ton for station loading and unloading, ad¬ 
vertising, damage, and, in fact, all services except haulage 
of 16.25 cents per ton. This amount was then divided by 
the average haul of the state traffic and produced a result 
of .1659 cent. In order to secure a comparison between 
the inter- and intra-state traffic, the average charge per ton 
was divided by the average haul of interstate freight, pro¬ 
ducing a result of .1092 cent. That is to say, by reason of 
the difference between the number of tons of state traffic 
and the number of tons of interstate traffic hauled by the 
carrier, and the variation in the length of haul between 
these two kinds of traffic, there is chargeable for expenses 
other than haulage .1659 cent on the local traffic and .1092 
cent on the interstate traffic. 12 

The Commission then proceeded to ascertain the cost per 
ton mile for haulage. This was accomplished by divid- 

11 The Commonwealth of Kentucky v. the Louisville and Nash¬ 
ville Railroad Company, et al., before the Railroad Commission of 
Kentucky, 1906. 

12 The expenses for terminal charges, damage, advertising, etc., 
were therefore 51 per cent more on intra-state traffic than on inter¬ 
state traffic. 




11 


ing the operating expenses for the state traffic by the 
number of ton miles of state traffic, which pro¬ 
duced a haulage charge per ton mile of .3884 cent. 
To this amount chargeable for haulage (.3884 cent) 
was added the cost for charges other than haulage (.1659 
cent) producing the fair estimated cost of all service for 
state traffic per ton mile, .5543 cent. By the same method 
the interstate cost for haulage was found to be .4976 cent 
per ton mile. That is to say, the cost of haulage was esti¬ 
mated to be the same upon state traffic as upon interstate 
traffic, while the cost for stations and other services except 
haulage, is more upon intra- than upon interstate traffic. 13 

At this point the Kentucky Railroad Commission ap¬ 
proached the serious question of the value of the physical 
property within the State and the amount of money which 
ought to be earned upon it. The Commission having been 
furnished by the carrier the physical value of the property, 
and having ascertained the rate of interest which securities 
of this kind are accustomed to produce, the quotations on 
stocks and bonds being considered, it remained to ascertain 
how the fair valuation should be divided so that one portion 
of it should produce adequate revenue from state freight 
and another portion produce revenue from interstate freight. 
The first proposition is to separate this valuation into 
freight and passenger business. While the Kentucky Com¬ 
mission assumes that this separation must be made, it does 
not seem to have done so. Having determined the proper 
total amount to be earned by the carrier, from both inter- 
and intra-state business, it attempts to ascertain what shall 
be used as a basis for dividing this fund equitably as be¬ 
tween the two kinds of traffic. “Certainly neither gross 
earnings nor net earnings can be a satisfactory basis of ap¬ 
portionment of these charges for this purpose, particularly 
where the purpose of apportionment is to determine the 
propriety of the rates from which gross earnings and net 
earnings result. In this case the earnings result from the 
rates in question. This annual charge for valuation is in a 
sense part of the carrier’s cost, and to attempt to justify 


13 The total cost upon the ton mile basis on intra-state traffic as 
found in this case is 11.4 per cent more than on interstate traffic. 



12 


the apportionment of costs by the earnings resulting from 
rates, and then to justify the rates by the apportionment of 
costs based on the earnings resulting from the rates, would 
clearly be reasoning in a circle. Nor can any suitable basis 
for apportionment of this annual charge on account of val¬ 
uation be derived from transportation statistics relating to 
passengers and freight, for the obvious reason that there is 
no common transportation unit, except the train-mile or 
car-mile, and the use of the train-mile or car-mile would 
give no help in apportioning between state freight and in¬ 
terstate freight, because no trains are devoted solely to 
either class of freight, nor is any considerable number of 
cars assigned exclusively to either class of freight. 

“Plainly, then, we have left only the operating expenses 
as a basis of apportionment.” 

Having determined that the operating expenses are the 
only available basis for apportionment, and being in pos¬ 
session of the operating expenses for both state and inter¬ 
state traffic and of the amount of money which would be 
needed to pay interest, it ascertained that the interest fund 
was 43.95 per cent of the cost of operation. It then took 
the operating expenses chargeable against state freight 
which it multiplied by 43.95 to ascertain how much money 
should be derived from the state business in order to con¬ 
tribute to the interest fund; that contribution was found to 
be $542,744. This sum was added to the state operating 
expenses and was held to represent the fair amount which 
the carrier should receive from the state traffic because it 
included the two elements of actual cost of operation and a 
surplus with which to pay interest. 

Commenting upon its own method the Commission said: 

“The Commission does not, of course, undertake to say 
that the computations, the results of which are hereinbefore 
set forth, are mathematically accurate, for it is universally 
conceded that any exact statement of the cost to a carrier 
for performing its freight service as compared with its pas¬ 
senger service, or for performing a part of the freight ser¬ 
vice as compared with the remainder, can not be made. 
The Commission has merely done the best it could with the 
figures and facts before it, but it has endeavored in all its 


13 


computations to make the most liberal allowance for actual 
valuation. Yet, with all this, we have a result showing 
charges by this carrier for intra-state traffic, within the 
State of Kentucky, which are more than $774,000, in ex¬ 
cess of just and reasonable rates.” 14 

From the adjudicated court cases it seems reasonably 
certain that the method used by the Supreme Court in 
Smyth v. Ames is inaccurate, for the relation which oper¬ 
ating expenses bear to gross receipts does not and can never 
show the cost of transporting the commodities. The method 
used by the Circuit Court of the United States for the Dis¬ 
trict of South Dakota could not stand the tests applied by 
the Supreme Court of the United States, which tests, it will 
be recalled, were different from the method formally used 
by that tribunal. The method used by the Kentucky Rail¬ 
road Commission is clearly more elaborate, if not more cor¬ 
rect, than those to which reference has been made by the 
Supreme Court. 

While the method of the Kentucky Railroad Commission 
is most elaborate, yet to determine with mathematical accu¬ 
racy the cost of traffic, a definite method has not as yet been 
devised. The difficulty is twofold. First, on the one line 
of road, with a single equipment, two kinds of traffic are 
carried. How is the capital to be separated for the pur¬ 
pose of producing revenue upon these two kinds of traffic. 
Again, the method used by the Kentucky Commission con¬ 
siders the whole schedule of rates, rates in gross, and secures 
its results in figures per ton per mile. In short, in the same 
focus it takes a broad survey of all kinds of commodities in 
the two kinds of traffic, and microscopically looks at the 
smallest possible unit of measurement. The shipment of a 
box of books is augmented to per ton per mile ; a shipment 
of a carload or trainload of vegetables is reduced to the same 
unit. While this unit may be used in mathematics, it can be 

14 For the l/ouisville and Nashville Railroad and some other car¬ 
riers, the Commission prescribed a schedule of rates based upon these 
findings. The schedule covers seventeen classes and distances from 
ten miles and less to four hundred and fifty miles (by five-mile steps 
to one hundred miles, and by ten-mile steps to two hundred and 
fifty miles, and by tw r enty-five-mile steps to four hundred and fifty 
miles). 



14 


confidentially asserted that it rarely, if ever, enters the head 
of a traffic manager making rates ; ordinarily he does not 
consider the cost of traffic, for he does not know it. , 

The difficulties in this matter seem to be the unwarranted 
assumptions—legal fictions, as it were—within which there 
might be such a variation as to cause rates (single or as a 
schedule) to be unreasonably low on the one hand or extor¬ 
tionate on the other. The assumption that the future quan¬ 
tity of traffic will remain the same, 15 the assumption that the 
average haul of both inter- and intra-state traffic will not be 
materially different, the assumption that operating expenses 
for a particular year are reasonable, the assumption what 
shall constitute fair valuation of the carrier’s property, the 
amount of tonnage it will transport, the fair rate of return, 
the arbitrary rule that all parts of the road cost the same to 
operate per unit, 16 the equally arbitrary rule that the rate of 
return ought to be the same for all roads and branches of 
roads, that the unit of per ton mile is a safe and equitable 
one, that any unit ought to apply to the eight thousand 
articles in numerous classes, that terminal expenses are the 
same for all classes of commodities, that the haul on inter¬ 
state traffic costs the same as on local traffic, and finally, but 
by no means unimportant, that the carrier shall give us cor¬ 
rect figures. These assumptions heretofore made may and 

15 It was said by Mr. Justice Brewer in Chicago Grand Trunk Rail¬ 
way Company v. Wellman (143U. S. 339), “Must it be declared, as 
matter of law, that a reduction of rates necessarily diminishes income? 
May it not be possible—indeed, does not all experience suggest the 
probability—that a reduction in rates will increase the amount of 
business, and, therefore, the earnings ? ” 

These suggestive queries were quoted and approved by Mr. Justice 
Shiras in St. b. & S. F. Ry. Co. v. Gill (156 U. S. 648). 

16 It is curious to note that a former president of the bouisville and 
Nashville Railroad analyzed the cost of carrying freight on the main 
line and on each of the different branches. Mr. Albert Fink summed 
up as follows : “A careful investigation shows that, under ordinary 
conditions under which transportation service is generally performed, 
the cost per ton mile in some instances may not exceed one-seventh 
of a cent and in others will be as high as seventy-three cents per ton 
mile on the same road.” That is to say, the cost may vary from one 
to five hundred. It is said that the receipts of the Paris and byons 
Company from Paris to Marseilles, about one-eighth of the entire 
trackage, produces one-half the net earnings of the company. 



15 


may not be true. Until proven correct, we cannot hope 
to ascertain to a mathematical certainty the cost of trans¬ 
portation to the carrier by any of the methods considered or 
one hereafter to be devised. 


Washington, D. C., February, 1907. 


9366-’05. 


100M—3-15-’06. 


( 10 ) 


4T TERA T 


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